Assessing UK Money Supply Measures in Light of the Credit Crunch

8/9/2019 Assessing UK Money Supply Measures in Light of the Credit Crunch

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FIRST DRAFT – PLEASE DO NOT CITE

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Assessing UK money supply measures in light of the credit crunch

Toby BAXENDALE

[email protected] Founder and CEO, Seafood Holdings

Anthony J. EVANS*

[email protected]

Assistant Professor of Economics, ESCP Europe

June 2009

Abstract

Following the credit crunch renewed attention has been given to the relationship between

the money supply and the operational efficacy of the Bank of England. We present a

theoretical definition of the money supply developed by Frank Shostak, called “Austrian

money supply” (MA) and present calculations for the UK economy. We find preliminary

evidence that MA provides a constructive interpretation of broader macroeconomic

activity and warrants further attention from academics and policymakers

Key words: asset bubble, credit creation, liquidity, monetary policy, money supply

JEL classification: B53, E41, E51, E52

* Contact author: Anthony J. Evans, Assistant Professor of Economics, ESCP Europe,

527 Finchley Road, Hampstead, London, NW3 7BG, United Kingdom; Email:[email protected]. We appreciate data and helpful comments from Frank

Shostak and Peter Stellios. The usual disclaimer applies.


2/21Electronic copy available at: http://ssrn.com/abstract=1416922


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“Credit creation is not just an important macroeconomic variable, it is the important

macroeconomic variable” George Cooper (2008, p.125)

Introduction

Following the 2008 credit crunch renewed attention has been given to the ability of

central banks to effectively monitor the quantity of money in circulation. This bucks the

trend of declining interest in monetary measures and warrants a reassessment of some

seminal questions. Any measurement of the money supply must ultimately rest on a

sound definition of money, however this is routinely taken for granted. This article

contests the orthodox treatment of money supply measures by policymakers, by

contrasting current measures of the narrow and broad money supply (M0 and M4) with a

measure pioneered by Frank Shostak (Shostak 2000), which we label “MA”. We find

evidence that MA is a more useful means to interpret broader macroeconomic activity

and warrants further attention from academics and policymakers. Section 1 provides a

coherent and robust definition of money. Section 2 looks at various types of financial

asset in light of the definition to determine what should and should not constitute being

part of the money supply. Section 3 applies these distinctions to the UK and presents the

UK MA. Section 4 concludes.

1. Definitions of money

It is worth considering whether the measurement of the money supply is a futile

endeavour. At least two important aspects of money imply difficulty in measurement –

it’s emergent properties, and its inherent subjectivism.

Carl Menger provided the seminal account of the origins of money in 1892 (Menger

1892). In it, he describes how money emerged as a consequence of its “saleability”. A

barter economy was unable to support a growing market economy, and a single

commodity – universally valued - emerged to satisfy the so-called double coincidence of

wants. Thus money emerged as a social institution to facilitate economic exchange, and it


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is this key characteristic that drives the definition.1 Our definition of money comes from

Rothbard:2

“Money is the general medium of exchange, the thing that all other goods and

services are traded for, the final payment for such goods on the market” (Rothbard1978, p.144)

Although its use as a medium of exchange is the primary function of money, this also

allowed money to serve secondary (and derivative) uses such as a store of value or units

of account. However this emergent property can make the boundary between what

constitutes money and what doesn’t appear blurred. Indeed as Horwitz says, “financial

assets have degrees of “moneyness” about them, and… different financial assets can be

placed along a moneyness continuum” (Horwitz, 1990, p.462). Although this might make

the classification of “money” more onerous, the existing practice of measuring the money

supply predicates an attempt to provide a less arbitrary definition. And yet even though

the emergent properties create a continuum of moneyness, these same properties tend to

result in a single asset being used in exchange. The fact that the value of money stems

from its use in exchange suggests that people will coordinate around relatively few

currencies.

The second reason why money is hard to measure is the inherent subjectivity. If an

entrepreneur chooses to retain cash balances it is because he deems that to be the most

profitable use of his scarce resources. The option to buy goods or lend the money is

1 On this see Menger and Mises, “And so it has come to pass, that as man became

increasingly conversant with these economic advantages, mainly by an insight becometraditional, and by the habit of economic action, those commodities, which relatively to

both space and time are most saleable, have in every market become the wares…Moneyhas not been generated by law. In its origin it is a social, and not a state institution”

(Menger 1892); “There would be an inevitable tendency for the less marketable of theseries of goods used as media of exchange to be one by one rejected until at last only a

single commodity remained, which was universally employed as a medium of exchange;in a word, money” (Mises 1980, p. 45)2 “As the general medium of exchange, money is a good universally and routinely

accepted in exchange by market participants... the one good that is traded for all other

goods on the market” (Salerno 1987, p.1)


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always available – at the right price. Therefore it is misleading to deem cash balances

“idle” or bemoan “hoarding” - the value of money, like the value of any other

commodity, is subjective, and stems from its availability (Hutt 1956, Horwitz 1990). The

whole point of a medium of exchange is that it is ready for use, and the only difference

between money that is “in circulation” or “idle” is the fraction of time in which it changes

ownership. This point drives straight to the heart of Keynesian orthodoxy that finds

relevance in the motivation that people have when holding cash balances and other liquid

assets. In reality the typical distinction between transaction, precaution and speculation

are not mutually exclusive, and “in analyzing them, it is less important to keep them

distinct than to keep track of the common element that binds them – the adaptation of

business dealings to uncertainty” (Hart and Kenen 19483).

Despite these difficulties, there are two main reasons why efforts to measure the money

supply make sense. Firstly, by grounding the concept of money in a tight definition it is

possible to make judgments about whether assets constitute being part of the money

supply in a non-arbitrary manner. Secondly, measures of the money supply currently

exist and to some extent the debate is not about the idealised ability to form monetary

aggregates, but given that aggregates are used, which are the least flawed. In practice that

which serves as the generally accepted medium of exchange tends to be easier to identify

than it might appear.

In March 2009 the Bank of England approached a lower bound for setting the Bank Rate

(0.5%) and to inject liquidity into the economy engaged in quantitative easing.

Consequently the “one target one tool” approach of managing the Consumer Price Index

through interest rates was replaced with a broader attention to the quantity of money.

According to the Governor, Mervyn King, “when we looked at the numbers we said…

that we thought that both broad money and the growth of nominal demand in the

economy were running at a growth rate which was too low to enable us to meet the

3 Cited in Salerno 1987, footnote 28, p.6, emphasis in original


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inflation target and see economy recovery.”4 This demonstrates that despite theoretical

and empirical doubts about the ability to define and measure the money supply, these

instruments are of direct policy significance.

In order to operationalise the definition of money, we identify the following

characteristics that would constitute whether an asset is part of the money supply:

A. A claim transaction - the depositor does not relinquish ownership of the asset

B. Redeemable for cash at par - the cash value does not fluctuate

C. Redeemable on demand - the saver does not need to give advanced notice

D.

Routinely accepted - commonly agreed to be “legal tender”

E. The final means of payment - it fully discharges a debt

2. Money supply measures

Before wading too deep in empirical associations, it’s important to stress the difficulties

in identifying robust statistical relationships. Arguments remain about whether key

indicators are leading or lagging, and what the stylised facts are, “these characteristic

qualitative features of most business fluctuations have not corresponded to persistence

regularities of the quantitative relationships that constitute the main focus of modern

business cycle analysis” (Friedman 1986). Indeed in the US in the early 1980s the

statistical relationship between M1 growth and major economic indicators (such as GDP)

began to fail as people moved money from savings accounts into NOW accounts5.

According to The Federal Reserve “M2 has been downgraded as a reliable indicator of

financial conditions in the economy, and no single variable has yet been identified to take

4 Comments made to a Treasury select committee in late March, cited in “Money supply

supplants rates on Bank’s agenda”, The Times, by Norma Cohen5 The former are part of M2 whereas the latter are also in M1. On the other hand, M1 has

been misleadingly low due to “sweeps”, which occur when banks shift funds from

checking accounts (M1) into savings accounts without reserve requirements.


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its place”6. It is commonly held that in the 1980s and 1990s financial deregulation led to

greater instability in the demand for money, thus making it harder to track. According to

some “the reliability of various money measures as useful indicators on which to base

policy has become seriously compromised” (Carlson and Keen 1996, p.15). Indeed the

Federal Reserve abandoned M1 targets in 1987, and M2 targets in 1992. In March 2006

they stopped publishing M3 statistics. The Bank of England abandoned M0 in May 2006.

These actions all call into question the usefulness of money supply aggregates, but what

if the aggregates were the wrong ones?

Our claim is that the failure of previous measures is due to the detail of their composition

rather than a fundamental problem with finding monetary aggregates. Typically the

definition of money stems from an arbitrary mixture of various liquid assets that happen

to correlate with national income. But if any mixture of liquidity is accepted, can’t retail

good inventories be included? A basket of commonly used shopping may well be as

liquid as stocks or bonds, yet without a tight definition of the money supply it’s hard to

justify their exclusion (see Baxendale 2005). According to Salerno,

“Measures of the U.S. money stock in current use in economic and business

forecasting and in applied economics and historical research are flawed precisely

because they are not based on an explicit and coherent theoretical conception of

the essential nature of money. Given the all-pervasive role of money in the

modern market economy, existing money-supply measures therefore tend to

impede, rather than to facilitate, a clear understanding of the past or future

development of actual economic events.”

Salerno 1987, p. 17

6 Comments by Alan Greenspan to a Congressional Testimony, July 1993

7 This view is supported by Shostak, “for the mainstream, the definition of money is

established through an arbitrary mixing of various liquid assets and then correlating this

mixture with another dubious statistic labelled national income” Shostak 2000, p.69


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In terms of prevailing US measures, M1 contains items such as currency in circulation,

travellers checks, demand deposits (i.e. checking account balances), and “other checkable

deposits”. M1 is typically about 10% of GDP. M2 also includes savings account, money

market deposit accounts, time deposits under a certain amount, and retail market money

mutual funds. MZM is a newer measure, which focuses on money with zero maturity (it

is essentially M2 less small time deposits but with institutional MMMFs) and is produced

by the Federal Reserve Bank of St Louis. M3 – an even broader measure – includes large

time deposits, balances in institutional money market funds, but excludes US government

assets or foreign banks and official institutions. Note that the broader the measure, the

less liquid the assets, and thus “money” is being defined more in terms of its function as a

store of value than as a medium of exchange. This creates a notorious degree of

arbitrariness in terms of where the line gets drawn between the degree of liquidity to

include.

Looking more specifically at the United Kingdom, M0 comprises of cash in circulation

outside the Bank of England plus banks’ operational deposits at the Bank of England.

This was a measure of narrow money, which was replaced in May 2006 by “Notes &

Coin and Reserve Balances”. Reserve balances are held by private banks at the Bank of

England, and bear interest. Due to the fast pace of financial innovation it had become

increasingly easy for people to substitute between narrow money (liquidity) and broad

money (interest bearing assets), leading the Bank of England to view little middle ground

between M0 and M4. According to a popular economics textbook, “Once we leave cash

in circulation, the first sensible place to stop is M4” (Begg et al, p.442). However the

convention of this dual narrow/broad approach takes for granted the theoretical validity

of the categories being incorporated. We follow seminal works by economists that

attempt to measure the money supply based on a clear definition of the defining

characteristics of money. For example, the “True Money Supply” (TMS) is compiled and

made available by the Ludwig von Mises Institute, Alabama. This follows Salerno

(1987).8 The other main Austrian measure is the “Actual” or “Austrian Money Supply”

8 Also see Rothbard (1978): “ Ma (a = Austrian) = total supply of cash-cash held in the

banks + total demand deposits + total savings deposits in commercial and savings banks


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(AMS), presented by Shostak (2000). The benefit of an Austrian approach is to apply a

coherent theoretical definition of money. Using our previous definition of money we can

make judgments about various asset classes:

Currency in circulation (cash)

The simplest place to start is the notes and coins held in the pockets and shoeboxes of

countries citizens. This is the chief component of the money supply – it is a universally

accepts means of payment. Cash provides the “physical embodiment of the generally

accepted medium of exchange” (Salerno 1987, p.2).

Demand deposits (checking account)

Irving Fisher made a distinction between cash (M) and demand deposits (M1), however

these deposits should be included in the money supply since they are redeemable for cash

at par on demand. If a consumer transfers cash from under the mattress to a checking

account, there is no change in the money supply (one component falls, another rises).9 As

Salerno states, “checkable deposits held at federally-insured banks and thrifts are readily

acceptable in exchange as perfect substitutes, dollar for dollar, for Federal Reserve notes”

(Salerno 1987, p.2)10

+ total shares in savings and loan associations + time deposits and small CDs at current

redemption rates + total policy reserves of life insurance companies—policy loansoutstanding—demand deposits owned by savings banks, saving and loan associations,

and life insurance companies + savings bonds, at current rates of redemption.” (Rothbard1978, p.153).9 In a world of fractional-reserve banking, however, demand deposits become a crucial

source of monetary expansion since banks will lend out some of that checking account.

This doesn’t alter the savers legal right to withdraw their asset at par and on demand, butdoes increase the amount of money in the economy.10

Only under 100 percent reserve banking are demand deposits cash redeemable, but thisdoesn’t matter. Provided that agents treat deposits as redeemable they are part of the

money supply (see Rothbard p.146) “ so long as demand deposits are accepted asequivalent to standard money, they will function as part of the money supply” (Rothbard

1978, p.145, emphasis in original)


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Savings deposits (savings count)

A distinction needs to be made between claim and credit transactions (Mises 1980). A

claim transaction occurs when the owner of a given amount of money stores it in a bank,

but retains ownership of the entire sum. This supposedly occurs in current accounts,

where the owner is entitled to withdraw their deposit at any time. By contrast a credit

transaction occurs when the owner of the money relinquishes immediate ownership,

permitting the bank to act as an intermediary and lend it out. This occurs in savings

accounts, where ownership is transferred from lender to borrower, and withdrawals can

only be made following a given time period. Another term for a “claim transaction” is a

demand deposit, whilst a “credit transaction” is term deposit. According to Salerno

(1987) “Savings deposits, whether at commercial banks or thrift institutions are

economically indistinguishable from demand deposits and are therefore included in the

TMS. Both demand and savings deposits are federally insured under the same conditions

and, consequently, both represent instantly cashable, par value claims to the general

medium of exchange” (Salerno1987, p.2) Rothbard points out that the legal incidence

isn’t as important as the economic reality, and the subjective beliefs of savers. If the 30-

day notice is not enforced – and savers don’t expect it to be enforced – those savings

should constitute the money supply. He claims that only a “ genuine time deposit…not

being redeemable on demand, would instead be a credit instrument rather than a form of

warehouse receipt” (Rothbard 1978, p.149, emphasis in original).

However according to Shostak, the key point is that banks could invoke a waiting period

before savings accounts can be accessed; crucially “when a depositor places his money in

a savings or fixed-term deposit, he temporarily relinquishes his ownership. This,

however, is not the case with demand deposits” (Shostak 2000). This takes us back to the

definition of money as a medium of exchange – if an asset is not directly transferable it


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will not be “routinely exchanged” and thus not be money.11

Shostak rightfully excludes

savings deposits because they are credit transactions. The key point is that although

people can draw a check on a savings account, to meet that obligation they must liquidate

part of their savings by transferring assets into a checking account. The savings account

does not act as a final payment on goods and services. If financial innovation results in a

savings account that can be drawn upon directly, this would no longer constitute

“savings” as we’re using the term, and become de facto demand deposits. Whereas for

Salerno savings are part of the money supply because they are “at all times transferable,

dollar for dollar, into “transactions” accounts” (Salerno 1987, p.3), for Shostak and us

they only enter the money supply if and when they are so transferred. Ultimately people

do not settle bills with a savings account-to savings account transfer.

The issue of savings accounts provides an example of the problems posed by the

subjectivism of money. For Rothbard if the general public believe (falsely) that money in

their savings accounts are instantly redeemable and act in accordance with this belief,

does this mean we should treat it as part of the money supply? We would contend that

money isn’t what people believe is purchasing power, but what is routinely accepted by

others. This provides the binding constraint, since merchants would only accept “savings”

that have been converted into either cash or a demand deposit.12

Money market mutual funds (MMMF), retail market funds and other securities

Crucially, the money supply is “all claims to dollars at fixed par values” (Rothbard 2005,

p.182). MMMF’s are not money because they are a form of investment that has a

11 (See footnote 10 of Salerno 1987, where he refers to White, "Definition and

Identification of Money," p. 310, and Yeager, "The Medium of Exchange," pp. 40-46, 53-

56). “The nub, however, is that savings deposits do not confer an unlimited claim”(Shostak 200, p.73)12

In another passage Rothbard seems to accept this: “They continue as equivalent to

money only so long as the subjective estimates of the seller of goods on the market think

that they are so equivalent and accept them as such in exchange” (Rothbard 1978, p.145,

emphasis in original)


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fluctuating price, thus are not redeemable at par. If an investor wishes to liquidate a

MMMF they must instruct a fund manager to sell a portion of their holdings and then

transfer the proceeds. Since these proceeds will fluctuate according to market conditions

it cannot be considered a final means of payment.

Shostak (2000) raises the issue that money market mutual funds (MMMF) can be

withdrawn on demand, but as Salerno points out “they are neither instantly redeemable,

par value claims to cash, nor final means of payment in exchange” (Salerno 1987) – and

thus not part of the money supply. Indeed it would be double counting to include

MMMFs in the definition of the money supply since money isn’t created when a deposit

is made – they are a neutral asset class. In addition to this retail market money funds are

clearly not part of the money supply since short-term debt (e.g. Treasury bonds or

commercial paper) are not routinely used as a media of exchange). Similarly shares are

not part of the money supply since they can only be sold to the market at fluctuating rates

and are thus not liquid enough to constitute “money”.

Certificates of deposit (CDs)

According to Rothbard small-denomination CD’s are redeemable at fixed rates (albeit

with a penalty discount), and he suggests including the instrument at the penalty level as

part of the money supply. For the US economy this also implies that federal savings

bonds (and other assets that are redeemable at a fixed rate such as cash surrender values

of life insurance policies) should go in. The crucial issue is whether there is indeed a

fixed time frame that prevents the asset holder from liquidating the value.13

Retail goods

13 But note that according to Salerno, “the ultimate decision to exclude the item was also

heavily influenced by the practical problem of obtaining the data necessary to permit areasonable estimate of its value in current dollars, i.e., net of penalty assessments”

(Salerno 1987, p.4)


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The example of retail goods provides a curious critique of many attempts to measure the

money supply. If liquidity is the main criteria (which is the case with stocks or bonds)

then it becomes hard to see why retail goods shouldn’t also be included. The reason is

because they are sold for money, and thus cannot actually be money.

Domestic government deposits

According to traditional measures if the government raises £1m through taxation, when

the money is transferred out of their deposit accounts this reduces the money supply by

£1m. If the money has simply been transferred from private to public accounts there

should be no change in the overall money supply – the money is still in circulation. As

Shostak points out, “in reality, however, the money is now available for government

expenditure, meaning that money held in government deposits should be part of the

definition of money” (Shostak 2000). We are concerned with “the total stock of money

owned by all economic agents” (Salerno 1987, p.5, emphasis in original).

Foreign government deposits

If foreign banks hold checking accounts in domestic institutions, these constitute part of

the money supply, since they’re denominated in sterling. Obviously time deposits should

not count for reasons mentioned above.

Travellers’ checks

Travellers checks are a credit transaction, and therefore should not be counted in the

money supply. “Cashing a traveler’s check means that AMEX or VISA will transfer

money from their deposits to the holder of the check, which will not change the amount

of money in the economy“ (Shostak 2000). Also, they are not routinely accepted as a

means of final payment, and “travelers’ checks issues by nonbank financial institutions…

are excluded… because they neither are riskfree claims to immediate cash nor serve as

final means of payment” (Salerno 1987, p.2) Traveller’s checks allow the existing money


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stock to operate more effectively, but they do not increase the availability of the media of

exchange.14

3.

The UK MA

We follow Shostak (2000) and define the money supply as having the following

components:

1. Cash

2. Demand deposits (with commercial banks and thrift institutions)

3. Government deposits (with banks and the central bank)

In contrast to M0 and M4 we present “MA” as an “Austrian” measure of the money

supply for the UK economy, and as shown in Table 1 the total value of MA as of March

2009 was £116,973m (! £117bn).

Table 1: Austrian money supply (MA) [Last updated: March 2009 ]

ComponentSeries name/code

(Source: Bank of England)

Latest

Period

Latest

value (£m)

1. Cash

“Monthly average amount

outstanding of total sterling notesand coin in circulation outside the

Bank of England total (in sterlingmillions) not seasonally adjusted”

LPMAVAA

31/3/09 53,008

2. Demand depositswith commercial

banks and thrift

institutions

Monthly amounts outstanding ofUK resident banks' (inc. Central

Bank) sterling retail deposits from

private sector (in sterling millions)not seasonally adjusted

31/3/09 852,968

14 Finally, sweeps should be part of the money supply, but can be difficult to find

accurate measures.


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LPMVQXW

3. Governmentdeposits with banks

and the central bank

Monthly amounts outstanding ofmonetary financial institutions'

sterling deposits from CentralGovernment (in sterling millions)

not seasonally adjusted

LPMVWLS

31/3/0930,091

Adjustment15

- 819,094

Total MA £116,973m

It is important at this point to note some data availability constraints. In July 2008 the

Bank of England reclassified £14bn of interest bearing assets into non-interest bearing

ones16

. In his data series Shostak thus uses retail banks deposits as a proxy measure for

“demand deposits”, and focuses on monthly changes from the pre-July 2008 measures

rather than the absolute values. This is why such a large adjustment is required, because

MA can no longer be measured directly.17

However despite these concerns the MA provides some important results. Figure 1 shows

the two predominant measures of the UK money supply (M0 and M4)18

together with

MA. This demonstrates that MA is a broader measure than M0 (since it also includes

demand deposits and government deposits) but significantly more liquid than M4. Amore relevant comparison is shown in figure 2, which charts the year on year change of

15 See comments in text

16 Formally the demand deposit section could be taken from the following series,

“Monthly amounts of UK residents banks (inc Central Bank) sterling non-interest bearing

deposits (inc. transit and suspense) from private sector”(LPMAUYA). But following thedecision to lump £14bn of assets into this measure it is no longer appropriate.17

By following Shostak’s method we replicated his measure of the Austrian moneysupply and this data is available on request. There is a period in late 1999 – early 2001

where our replication overestimates the official data. This is due to massive increases ingovernment deposits recorded during this period, which were adjusted by Shostak. Aside

from the fact that a perfect replication is not the objective of this paper, we acknowledgethat such adjustments constitute the added value of the analysis provided by Shostak.

More importantly, this also demonstrates the limitations provided by the existing data.18

Although M0 was discontinued we use this to label the narrow measure of the money

supply out of convention


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all three measures. Both conventional measures exhibit little deviation over the 10-year

period of study, demonstrating why money supply measures have lost favour as a means

of interpreting economic activity. However MA provides some immediate points of

interest. The period around the “dotcom bubble” can clearly be detected with over 25%

growth rates in the quantity of money, and following this a deflationary period in early

2003. The build up to the present financial crisis coincides with sustained positive growth

(above the rate of consumer price inflation) that collapsed in early 2008 and remains

negative throughout that year. Even a cursory inspection of the series suggests it is worth

further attention.

This paper intends to provide an interpretation of recent economic history through the

lens of a new measure of the money supply. Carlson and Keen (1996), and Teles and

Zhou (2005) provide a more formal approach to justifying attention on a new monetary

aggregate, MZM (money of zero maturity). Interestingly MZM is a similar measure to

MA in that it focuses on highly liquid assets, but no measure exists for the UK at present.

This points to the lack of data that mitigates the confidence we have in compiling such

“novel” series, and the inherent difficulty of relying on central bank data that is compiled

with little attention to the theoretical considerations that concern us. We therefore feel it

would be inappropriate to pursue a similar approach and instead the methodological goal

is more focused on broad relationships than to provide a robust statistical test. In short,

our focus is on the theoretical validity of the measure and the data is provided as a

cautious justification of its relevance. Even at this level of abstraction the results are

notable. Figure 3 takes “Real MA” (the MA measure adjusted for CPI) and plots against

Industrial Production. Figure 4 correlates Real MA to GDP, where we have incorporated

an arbitrary 12-month lag. Figure 5 shows Real MA against retail sales, also with a 12-

month lag. On all counts MA offers close approximations for economic activity. The

failure of Long-Term Capital Management following the Russian crisis of 1998 can be

observed with a monetary deflation in that quickly turned into a massive expansion in the

money supply during the dot com boom. At it’s peak the MA was running at over 25% a

year, the subsequent bursting of this bubble led to a prolonged decline in the growth rate

of MA (including a massive drop following September 11th

2001) and subsequent

deflation in 2003. The most remarkable observation is the consequence of the steady


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expansion during 2006 and 2007. In January 2008 the MA went from a 10% year on year

growth rate to -4%, demonstrating the sharp contraction that resulted in Bear Stearns and

Lehman Brothers. Contra M0 and M4 this monetary deflation continued throughout 2008

reaching lows of -10% in October.

4. Conclusion

This article investigates an alternative measure of the money supply, MA. Despite

difficulties in data availability, a brief comparison with relevant economic indicators

demonstrates that in contrast to M0 and M4 monetary aggregates can have an empirical

manifestation. As policymakers increasingly target money growth instead of interest rates

there will be increased attention to measures of the money supply. It is important to recap

on the purpose of money supply measures. Traditionally these have been deemed to play

a crucial role in explaining the future path of the real economy over the shorter term, as

well as being the root cause of price inflation. Although existing monetary measures have

been less than exemplary for forecasting, our contention is that this is primarily due to

theoretical issues regarding the choice of measure. By providing a brief history of the

present we see that MA deserves appropriate consideration and further scholarly research.


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Appendix

Figure 1: UK money stocks

Figure 2: Change in UK money stocks


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Figure 3: Real MA vs. Industrial Production

Figure 4: Real MA vs. GDP (12 month lag)


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Figure 5: Real MA vs. Retail sales (12 month lag)

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Assessing UK Money Supply Measures in Light of the Credit Crunch

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